ACCOUNTING FOR PENSIONS AND POSTRETIREMENT BENEFITS

Intermediate Accouting; Chapter 20

By: Dhivena Leanti Ardhan – 185020307141002
A. Fundamentals of Pension Plan Accounting
Pension plan is an arrangement whereby an employee provides benefits (payments) to
retired employess for services they performend in their working years. Pension accounting
may be divided separately as accounting for the employer and accounting for the pension
fund. The company or employer is the organization sponsoring the pension plan. A pension
plan is funded when the employer makes payments to a funding agency. The fund or plan is
the entity that receives contributions from the employer, administers the pension assets, and
makes the benefit payments to the retired employess (pension recipients).
Some pension plans are contributory and non-contributory. The pension fund
should be a separate legal and accounting entity. The two most common types of pensions
plans are as follows. (1) Defined contribution plans: The employer agrees to contribute to a
pension trust a certain sum each period based on a formula. This formula may consider such
factors as age, length of employee service, employer’s profits, and compensation level. Only
the employer’s contribution is defined; no promise is made regarding the ultimate benefits
paid out to the employee.
(2) Defined benefit plans: The employee will receive at the time of retirement. The
formula typically provides for the benefits to be a function of the employee’s years of service
and the compensation level when he or she nears retirement. Employers are at risk with this
plans because they most contribute enough to meet the cost of benefits that the plan defines.
The expense recognized each period isn’t necessarily equal to the cash contribution.
Valuing the pension obligation. One measure bases the pension obligation only on
the benefits vested to the employees. Vested benefits are those that the employee is entitled to
receive even if he or she renders no additional services under the plan. Another way to
measure is using current salary levels. This measurement of the pension obligation is called
the accumulated benefit obligation. A third measure is using future salarie is called
defined benefit obligation also referred to as the funded status is the deficit or surplus
related to a defined pension plan
Defined Benefit Obligation – Fair Value of Plan Assets (if any)
Reporting Changes in the Defined Benefit Obligation (Asset). The three
components are as follows. (1) Service cost: The increase in the present value of the defined
benefit obligation from employee service in the current period. To determine current service
cost and the related increase in the defined benefit obligation, companies must apply an
actuarial valuation method, assign benefits to period of service, and make actuarial
assumptions. (2) Net interest: Computed by multiplying the discount rate by the defined
benefit obligation and the plan assets.
Using A pension Worksheet. A worksheet is not a permanent accounting record.
Companies may use a worksheet unique to pension accounting. This worksheet records both
the formal entries and the memo entries to keep track of all the employer’s relevant plan
items and components. The ending balance in the Pension Asset/Liability column should
equal the net balance in the memo record.
B. Remeasurement
Arise from gains and losses on plan assets and on the defined benefit obligation. The
gains and losses on plan assets is the difference between the actual return and the interest
revenue computed in determining net interest. Asset gains occur when actual returns exceed
the interest revenue. The gains and losses on the defined benefit obligation are due to changes
in actuarial assumptions that affect the amount of it. All remeasurements are reported in other
comprehensive income.

C. Reporting Pension Plans in Financial Statements

1. Within the Financial Statements

 Pension Expense. Affects net income and is reported in the statement of

comprehensive income.
 Gains and Losses. By recognizing these but not net income, the Board belives that
the usefulness of financial statements is enhanced
 Recognition of the Net Funded Status of the Pension Plan. The overfunded or
underfunded status is measured as the difference between the fair value of the plan
assets and the defined benefit obligation.
 Classification of Pension Asset or Pension Liability. The current portion of a net
pension liability represents the amount of benefit payments to be paid in the next 12
months (or operating cycle, if longer) if that amount cannot be funded from existing
plan assets. Otherwise, It will classified as a non-current liability.
 Aggregation of Pension Plans. The only situation in which offsetting is permittted is
when a company has a legally enforceable right to use a surplus in one plan to settle
obligation in the other plan and intends either to settle the obligation on a net basis, or
to realize the surplus in one plan nd settle is the obligation under the other plan
simultaneously.
2. Within the Notes to the Financial Statements
To increase understanding pension plans, a company is required to disclose
information that: (1) Explains characteristics of its defined plans and risks associated with
them, (2) Identifies and explains the amounts in its financial statements arising from its
defined benefit plans, (3) Describes how its defined benefit plans may affect the amount,
timing, and uncertainity of the company’s future cash flows

D. Other Postretirement Benefits

Item Pensions Healthcare Benefits

Funding Generally funded. Generally non funded.
Benefit Well-defined and level dollar Generally uncapped and
amount. great variability.
Beneficiary Retiree (maybe some benefit Retiree, spouse, and other
to surviving spouse). dependents.
Benefit Payable Monthly. As needed and used
Predictability Variables are reasonably Utilization difficult to
predictable predict.
 Companies often provide other types of non-pension postretirement benefits, such as
life insurance outside a pension plan, medical care, and legal and tax services. The IASB
indicates that the accounting and reporting of these other types of postretirement benefits
should be the same as that used for pension plan reporting. Companies with both plans must
separately disclose the plan details when the plans are subject to materially different risks.